Brace for Possible Asset Bubble Implosions

If asset bubbles continue to build up under China's loose monetary policy, it would be wise to allow private enterprises to enter state-monopolized sectors.

By Chen Changhua

(Caijing.com.cn)
Daily turnover on the Shanghai Stock Exchange has recently soared above 200
billion yuan, the level the bourse reached when it was about to crash at the end
of 2007. The real estate sector is also overheated and my colleagues in
Shanghai have told me that housing prices in Shanghai's Pudong district have
risen over 30 percent from the beginning of the year.

China's nominal gross domestic
product grew 3.8 percent in the first six months of 2009, compared with 19.8
percent for the same period in 2008. Such an economic slowdown indicates heavy
deflationary pressures.

Exports, one of the three main
contributors to China's economy, plunged in the first half. Domestic consumption
also dropped slightly. Only the pace for investing picked up quickly, due to the
loose monetary policy.

Government-backed infrastructure
projects and large industrial ventures by state-owned enterprises account for a
majority of new lending and investment. Without this surge in investment, the
real economy would have fared much worse.

The boom in stock and property
markets is closely linked to the current loose monetary policy. In June 2009,
M2, the broadest measure of money supply, jumped by 28.5 percent year-on-year,
compared with 17.4 percent for the same period in 2008. New lending accelerated
to 34.4 percent year-on-year in June 2009, compared with 14.1 percent for the
same period in 2008.

Through bank lending and money
supply, liquidity has been ample in the market. However, nominal GDP growth
lagged far behind the growth in lending and money supply, which could raise
suspicion that a large portion of the funding has entered asset
markets.

In the next one or two years, the
global economy won't be able to recover and, due to overcapacity, consumer price
index (CPI) will not be able to rise sharply. Even if the central bank wants to
tighten money supply then, various aspects of society won't support it. It's no
longer a question of whether the central bank should rein in its loose monetary
policy, but whether or not it will actually do it.

China's fiscal and monetary
policies in the past few years have placed growth before anything else. It is
unlikely that the Chinese government will raise interest rates when economic
recovery has not yet been secured.

Bubbles in stock and property
markets have not formed yet but the conditions and potential for the birth of
bubbles are already in place. It is just a matter of time.

As we can see from financial and
economic history, the real economy is always stimulated during a process of
bubble formation. But after the bubbles are punctured, the fallout is horrible.
Post-1990 Japan, Southeast Asia after the financial crisis and the United States
in the next five or ten years are such examples.

If China's loose monetary policy
cannot be reversed in the long term, we have to ask ourselves how we can channel
massive funding to areas that will be beneficial to the economy in the long
term, rather than let the Chinese engage in speculative activities in stock and
asset markets.

I think that allowing private
enterprises to enter areas currently monopolized by state-owned companies would
be a good way to use funding.

Though China's manufacturing
industry is already top of the line, much can be improved with its service
sector, including banking, securities investment, telecommunications, civil
aviation and domestic trade. China has attempted to open areas such as civil
aviation to private enterprises, but to no avail.

You may be asking: But why will
the entry of private enterprises cushion the blow delivered by asset bubbles, or
even mitigate the negative impact of bubble implosion? The answer lies
thus:

Chinese individuals and
enterprises are enthusiastic about speculation in stock and property markets
mainly because there are not many investment alternatives.

China's wealthiest often invest in
the real estate sector because it is one of few industries open to private
capital. Banking, insurance, securities, telecommunications, power and energy
industries are pretty much not open to private firms.

Some industries may be open to
private firms in theory, but in practice, private enterprises undergo very slow
processes of development for various reasons. If China fosters a positive
environment for private investment, funding that now lies in stock and property
markets may be transferred to real industries. This would effectively reduce
asset bubbles.

From books I've read as well as
real life experience, I am convinced that private enterprises are more efficient
than state-owned firms. State companies are far less aggressive than private
ones in terms of innovation.

It is true that state-owned
enterprises have improved greatly since the 1990s but it is not a reason to bar
private enterprises from certain areas.

Actually, if state-owned
enterprises are supposedly very competitive, why do they fear competition from
private rivals? If more industries are open to private capital, economic
efficiency would improve accordingly, and the long term negative effect on the
economy inflicted by impending assets bubbles will be reduced.

How quickly a country can recover
from an economic slump is determined by the productivity of the country. Japan
has not been able to recover from the 1990 slump mainly because there are not
enough competitive new-generation enterprises to replace old
enterprises.

If it is difficult to avert a new
round of asset bubbles, then opening domestic markets to private enterprises is
a good option.

In the past few years, state-owned
enterprises have become larger and stronger while playing the role of the
offense while private enterprises have been on defense. Maybe it's just a hope
of mine that private enterprises will muster their forces soon as
well.

Chen Changhua is the head of
the China Research Department at Credit Suisse.

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